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Junk Loans Set to Ditch Faxes

Efforts underway to automate the market for junk-rated loans as Moody’s warns about the time required to cash out.

Efforts under way since 2007 to automate the $750 billion market for junk-rated corporate loans may soon pay dividends just as Moody’s Investors Service warns managers may not be able to refund investors trying to flee.

The International Swaps and Derivatives Association may start reviewing as soon as this month whether electronic notifications aimed at automating quarter-end payments and interest rates are ready to be used instead of fax machines, Bhavik Katira, chair of an ISDA group responsible for the initiative, said in an interview. Messages focused on cutting the time its takes to settle a trade from the current three weeks could also be sent for approval this year.

Modernization can’t come soon enough for loans, which have been identified by regulators as a source of concern due to deteriorating underwriting practices. After receiving a record $61.3 billion last year, loan mutual funds have seen eight consecutive week of outflows, with Moody’s now saying that managers may struggle to raise cash to meet investor redemptions if too many try to exit at once.

“It’s a long time coming,” said Ken Katz, director at Misys, a London-based provider of banking software. “Every other financial market at this point is light years ahead of where the loan market is in terms of automation.”

The electronic notifications “bring the loan market into the 21st century,” he said.

Messages regarding inventory positions, which let lenders know the balance of their holdings, will go for review at the same time, Katira said. A go-ahead would clear the system for a wider group of market participants.

A final recommendation may come toward the end of the year, Karel Engelen, senior director at ISDA in New York, said in a telephone interview.

Transmissions focused on trading will be sent for ISDA scrutiny in either October or November, said Katira, who is also chief executive officer of TenDelta LLC, a financial technology consulting firm focused on syndicated loans. They will pertain to settlement information exchanged between the bank arranging a loan and the two counterparties to the trade.

Unlike high-yield bonds, which settle in three days, it took an average of about 23 days during the first quarter to complete a loan trade, according to the Loan Syndications and Trading Association.

Unlike stocks and bonds, loans aren’t securities, which means the debt isn’t overseen by the U.S. Securities and Exchange Commission.

Automation’s ‘Benefit’

The amount of loans exchanging hands rose to $517 billion in 2013, a 31 percent increase from 2012, according to the LSTA.

“Any automation that can expedite” settlement “is a benefit to the asset class,” said Jason Rosiak, head of portfolio management at Newport Beach, California-based Pacific Asset Management, the Pacific Life Insurance Co. affiliate that oversees about $4.4 billion. “Especially because the asset class has become more mainstream.”

Leveraged loans are booming with issuance of new debt reaching $221.9 billion in the U.S. this year, after a record $357.9 billion in all of 2013, data compiled by Bloomberg show. The growth was aided by the streak of 95 straight weeks of inflows into loan mutual funds that ended April 16, according to Lipper. Since then investors have withdrawn $4.94 billion.

Froth in the market has drawn the attention of the Federal Reserve and the Office of the Comptroller of the Currency who have warned of deteriorating underwriting standards and are increasing pressure on banks to curb risky lending.

The gap between the time it takes to settle a loan trade and when managers must return money to investors may pose “potential liquidity risk for fund products and potential reputational risks for sponsors,” Moody’s analysts led by Stephen Tu wrote in a July 7 report. Loan settlement times are slow due to the private nature of the asset class.

“Liquidity is an issue for all fixed-income asset classes with the new regulatory framework limiting the amount of capital provided by the dealers,” Rosiak said in a telephone interview. “This is not just an issue for bank loans.”

Work on Financial products Markup Language for loans began in 2007. The standard is used in other over-the-counter markets.

“It’s not too often that you see a product where there’s a structural gap,” with a mismatch in liquidity between assets, Tu said in a telephone interview.

FpML Advantage

“Loans have their own idiosyncrasies and we hope this will clear the misinformation,” Katira said. FpML will allow the market to focus “on real issues that will make settlement easier.”

JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. are currently sending electronic messages to a unit of Markit Ltd., according to Mark Schultis, a managing director in Dallas at the financial-information provider.

About five percent of messages pertaining to post-settlement notifications, such as interest-payment information, are electronic, Schultis said. That’s up 15 percent from 2013.

Mark Pipitone, a Bank of America spokesman, Justin Perras, a JPMorgan spokesman, and Rob Julavits, a Citigroup spokesman, all declined to comment.

FpML can reduce the risk of mistakes associated with manually typing in data, as well as eliminate faxes, said Misys’ Katz. The loan servicing vendor is currently using FpML for non-trading messages such as interest payments.

“By seamlessly transferring information” using FpML, “data accuracy is virtually assured,” said Ellen Hefferan, senior vice president at the New York-based LSTA. That is “no doubt a goal of the loan market.”

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